Tuesday, January 04, 2011

If it's not a VAT rise, what are the alternatives?

It's VAT Rise Day today. The Opposition, the self-appointed "Taxpayers' Alliance" and the Beer Retailers Association have all made noises opposing the rise. So what are the alternatives?

The first is to do nothing. This may be comfortable for some commentators and is often a line adopted by some in the Labour Party. It saves their having to put forward an alternative and proffers the scenario of there being no problem so there's no need for pain. The simple problem is that instead of being a "do nothing" option, it amounts to a "put off the evil day" option. And as we all know, the longer a problem is left to fester, the bigger it gets. If nothing is done to address the deficit now, cuts in the future will be much greater to pay for the additional interest on growing government debt. Those who promote the "do nothing" option should tell us what services they will cut or which taxes they will put up in future just to cover the additional debt charges. And for good measure, they should also tell us what measures they will introduce to eliminate the structural debt.

The second option is to make the banks pay for the deficit. This is an attractive option for those who feel obliged at least to put forward an alternative, no matter how shallow. It is popular with those who realise there is a problem but feel they can get away with offering a no pain solution (ie no pain except for the banks). This option has an unintended consequence. Taking £12 billion (the amount raised by increasing VAT) from the banks in a single year will mean £12 billion less capital available from the banks to invest in business or to lend to retail and mortgage customers. Given the difficulties businesses have getting affordable finance from the banks, an excessive tax on financial services could massively reduce the capital available to invest in British jobs and companies. A £12 billion levy on the banks would also not be a one off. The VAT rise will rais revenue year in, year out until such time as it is reversed. A £12 billion bank tax would have to be applied every year. Such a gigantic tax on one sector of the economy would end up undermining the banks in the medium term. Do we really want the banks to come close to collapse, repeating the events of 2008, especially as the public sector is now the biggest individual shareholder in the banking sector?

It is right that the banks should pay a levy and the Coalition has introduced such a tax. However, it has to be set at a level that does not undermine the rest of the economy. There is a fine balance and the government has set the level of the levy accordingly.

The third option is an increase in income tax or national insurance contributions. Well, the latter are going up anyway by 1% (a decision made by the last government but retained by the Coalition.) I've already had a letter from the Inland Revenue telling me I will be paying more class 2 contributions. Novertheless, a further rise in income tax and NICs would undoubtedly raise additional revenue for the government. The problem is that higher rates on people on low and middle income act as a disincentive to work and often lock people into poverty by making them better off on benefits than they would be if they worked. NIC and income tax rises also shift more of the tax burden onto the working population. VAT however spreads the burden across the whole of the population.

No one likes a tax rise. All the options have drawbacks. They all have unintended consequences. Those who argue against the VAT rise have every right to remain silent about what they would do instead (Labour remained silent about their plans to raise VAT to 19% until Peter Mandelson let the cat out of the bag). Nevertheless, it would be interesting to hear from those making the most fuss (largely Labour) as to what their alternative is. Labour claim to be against any VAT rise now (another Labour uturn, but are exercising their right to remain silent over their own alternatives.)